By April McDaniel, Kopsa Otte
As a CPA in one of the few Accounting & Tax Firms specializing in the Beauty Industry, I frequently see business owners making mistakes in areas of tax reporting. The term “owner” includes solo artists and managers of large employee-based teams. Quite honestly, this area of tax is low hanging fruit for auditors. Despite this, many business owners do not seem to think they are under scrutiny — but I think it’s only a matter of time. The IRS continues to increase efforts to improve the accuracy of tax returns through a system called “matching documents,” which checks critical numbers on tax returns with external forms.
Here are a few examples:
- Form W-2 and W-3: Box 7 on the IRS forms is used specifically for reporting tip income. If you work in an industry where tipping is common, and your business accepts tips then there should be numbers in the box for tips.
- The 1099-K: This form is used for various purposes, including reporting of transactions in cash apps. The threshold requirements have changed over the last few years.
It used to be that payments exceeding $20,000 and 200 transactions received via cash apps would trigger a 1099-K, and the IRS looks to match that income on your tax return.
In 2022, it was announced this threshold would be reduced to payments exceeding $600. This was never implemented as it was determined not feasible given the timeline of implementation. In November 2024, the IRS introduced transition relief for third-party settlement organizations (TPSOs) like payment apps and online marketplaces. For transactions in calendar years 2024 and 2025, TPSOs will report when total payments for a given account exceed $5,000 in 2024, $2,500 in 2025, and $600 in 2026 and beyond. - Credit Card Processing and Cash Business: The 1099-K is also used to report credit card processing. The IRS expects that you have some cash business. If the total gross receipts reported on your business schedule or business return does not provide for some cash income above and beyond what is reported on the 1099 issued by your merchant processor that is a red flag. This is what I mean by low hanging fruit.
What Can You Do as a Business Owner?
To be prepared for tax season, here are some steps you can take:
- Track Your Income and Expenses: Use software like QuickBooks Online to keep a clear record of your business transactions.
- Separate Finances: Set up a separate bank account and credit card for business use. Don’t mix personal and business expenses.
- Stay Consistent: Spend a few hours a week on your business records. It’s far easier to stay on top of things than to scramble when tax time arrives.
- Estimated Tax Payments: Consider discussing estimated tax payments with your tax preparer. This helps with cash flow, as you can make payments to the IRS throughout the year, instead of waiting until the tax deadline.
- File Your Extension Correctly: If you extend your tax return, remember that it’s an extension to file, not to pay. Interest and penalties will apply if you owe taxes and haven’t made estimated payments or an extension payment.
- Track Retail Used as Back Bar: Many states require sales tax on retail used in your business, so be sure to keep track of that.
- Sales Tax: Collect, remit, and file your sales tax returns as required by your state.
- Tip Reporting: Tips, including gifts, cash, credit card tips, and cash app income, are all subject to FICA tax. It is up to you to enforce the rules.
- Employees: If you’re an employee, report your tips to your employer for inclusion on your W-2. Your employer will pay half of the FICA, and you will pay the other half.
- Self-Employed: As a self-employed individual, report your tips on your tax return. Discuss this with your tax preparer to ensure compliance.
The Bottom Line:
We are seeing more enforcement. Lately salon owners are receiving balance due notices from the IRS for past tax due on tips not reported. You might ask how that is happening? An employee goes to file their tax return and they are asked if they had any tips received that they did not report to you (the owner). They report additional tip income at that time. This also may happen because the employee is struggling to get a loan for a car or house because their tax return does not reflect their true income. The IRS picks up on this reporting in some cases and sends out the balance due notice for the owner to pay their share of the FICA tax.
Knowledge is power, and when you measure it, you can manage it effectively. If you aren’t keeping track of these details, it’s impossible to plan your taxes efficiently. Pay attention, and make sure your records are up-to-date.
By following these steps, you’ll avoid red flags and ensure your business is set up for tax success.
There are a lot of things on the political scene right now when it comes to tip tax laws. From a possible tip tax credit to eliminating taxes completely on tips. It’s important to keep watch and be informed of any changes. If you want the latest updates please sign up for our newsletter at www.kopsaotte.com.